The emerging institutional risks from adoption of an

The emerging institutional risks from adoption of an ecosystem services market approach to environmental governance Paul V. Martin, Amanda Kennedy, Jacqueline Williams.

2 distinct mindsets in commerce 1. Innovator and entrepreneur 2. Risk manager Risk is the ‘ying’ to opportunity’s ‘yang’ The first dominates the ‘naïve enthusiasm’ stage of commercialisation. The second emerges from experience. Can we minimise the costs of naivety?

Paper based on 3 studies. 1. A “Policy Risk Assessment” framework for identifying policy risks in water markets. (CRC Irrigation Futures, Martin and William). 2. Property right risks of market instruments (Australian Govt. Martin, Binney, Kennedy, Williams, and Page). 3. Study of impediments to innovative control of weed risks associated with biofuel production. (Elodie Le. Gal et. al. ) Institutional path dependence, political economy and transaction costs risks. Q. Do we need a better informed approach to market instrument risk identification and management? A. Yes we do!

Eco-system services markets • Terminology denotes various business models (including anticipatory service). • Rapid adoption, e. g. – Payments for watershed services. – USA 2008 16. 4 million hectares of land, payments in excess of $1. 3 billion. • Successes are touted, but (as with market instruments generally) failure is concealed. • Evidence of success should not conceal the reality of risk, and the potential costs of failures.

In the real world, novelty = inevitable risk. • Commercialised innovations are often ‘boosted’…. • … but early failures are the norm. – The shift from concept to prototypes to useful innovation is littered with failures. – The journey is likely to be littered with painful lessons, some of which might be avoided by foresight. • Risks decline with experience: fewer mistakes, and efficiency. – the accumulation of learning from prior mistakes – from observation and analysis (“the learning curve effect”), – greater scale and sophistication in equipment and skills (“economies of scale”).

Reliability and efficiency through experience Least-cost delivery of benefits Highefficiency Voluntary stewardship Tradeable ecoproperty Where do these fit? • Eco-labelling Voluntary • Auctions of subsidy Subsidy engagement • Voluntary programs auctions • Co-regulation • Policed regulation Partnered • Tradeable permits regulation • PES Eo-labelling and standards Ecosysterm service markets Traditional policing How will PES become reliable? - Experiential learning (mistakes) - Specialisation (inexperience) - Entrepreneurship (exploitation) Lowefficiency Novel Time, cumulative experience and learning Where are we now? Mature

3 categories of policy risk Scoping and Synthesis Political Risks Spillover Risks Instrumental risks

Risk Category 1: “Instrumental risks” The risk of under-performance or failure due to misdesign or poor implementation viz. • Unreliable behavioural effectiveness. • High or misallocated transaction costs • Problems of economic feasibility • Insufficient strategy and implementation ‘platforms’.

Markets: institutional and instrumental risks 1. Failures of institutional governance, credibility and efficiency. 2. Reliability of information, viz. ‘transaction costs” (equivalent to friction). 3. Insufficient implementation ‘platform’ (incl. securitisation of interests). 4. Adequacy of the resource platform of the government or private agency. 5. The resource platform of market participants whose actions are meant to change. 6. Adequacy of demand supply.

How reliable is the driver of market demand in PES? • Possible to contrive this demand by institutional arrangements. • These generally depend upon government, an unreliable market-maker. • Intrinsically an artificial price. • Community resistance to taxation or effective regulation. • Insufficiency or unreliability of contrived demand is a material risk (e. g. Pennsylvania methane generated electricity).

The fiscal basis for public PES? • How reliable is government funding for ‘market -like’ PES? • To what extent will we be able to move from experiment to systemic use, if this relies on government support? National fiscal projections

How broadly applicable is the ecoservices market model? GDP/km 2 Mongolia Great Britain Iceland Australia USA China 0 5 10 15 20 25 30 35 40 Population/km 2 GDP/Capita Mongolia Great Britain Iceland Australia USA China 0 10, 000 20, 000 30, 000 40, 000 50, 000 60, 000 0 50 100 150 200 250 300

Will transaction costs make PES markets vulnerable? In a world without transaction costs there could be no externalities. Daniel Bromley TC sources with PES include: • The number and complexity of the institutions, instruments and strategies. • The difficulty with which key transactions are implemented. • Transacting steps. • Quantification and measurement. • Difficulties in communication.

Markets – the resource governance frontier AIR-LINKED Tree carbon Pasture carbon Foregone clearing WATER-LINKED Surface water Groundwater Salinity Pollutants PRODUCT-LINKED Food Fibre Fuel Finances ? ? s t ? n m e d e r t u INTELLECTUAL SUPERVENING e s a h y r f s o ty r c Cultural Family/society o n i i t r n g ecu Aesthetic Services e n i m om e s y Intellectual property Finances KS a l c p t S i e t r b RI e f v ty ity o r O e l p i 1. o b r P nera. 2 GROUND-LINKED BIODIVERSITY ul INCHOATE V Iconic species. 3 Minerals Development rights Iconic habitats Oil Non-iconic Gases biodiversity Soils Ownership dimensions Period/temporality, Security, Exclusion, ……. Cultural values Others? ?

Governance Risk: ‘gaming’ under weak supervision. The ‘costs of government information’ logic of PES instruments. • “Putting the fox in charge of the henhouse”? • The line between ‘entrepreneurship’ and ‘gaming’ or ‘cheating’ is not clear • PES schemes and property entrepreneurship • Suspicion of dishonest trading prejudices markets • Strong governance structures are not likely to naturally emerge ahead of market maturation.

Risks Category 2: Political risks • Political frustration of the policy intent. • Agency frustration of implementation • Community frustration of implementation

Hidden risks of “marketising” stewardship • ‘Crowding out’ voluntary action. The extent of this effect is unclear. • Public discourse and action reframed to payments for services, not stewardship. • Messiness of democratic contests ( via open law, parliament) replaced by ‘efficient’ administration and contract (via nontransparent negotiation and bureaucracy). • Scientific model risks are embedded but hidden within property allocation.

Hidden risks of ‘propertyising’ environment • Focuses governance onto the efficient operation of the competitive mechanism. • Sanctity of the market is entrenched by competition policies. • Property rights as superior interests; noneconomic values are subordinated or silent. • Best practice limits ‘interference’ by notproprietorial rights, or contestation other than by ‘elite’ interests. • Government action is circumscribed.

Satyajit Das. European governments have deliberately moved key decisions outside the electoral and parliamentary process…. . European policy makers appear to believe that a suspension of democracy and sovereignty to allow the implementation by trusted technocrats of centrally determined policies is the answer. As Bertold Brecht observed in 1953 about the suppression of workers in East Berlin: “The people having lost the confidence of the government: the government finds it necessary to dissolve the people and appoint a new one. ” A democracy deficit is now as much a problem as budget and trade deficit

Risks Category 3: “Spillovers” • Unanticipated or excessive risks to vulnerable interests – Environment e. g. partial pricing/ partial management – Society e. g. poor people access – Economic e. g. competitive impacts on ‘adjacent’ industries • Particular concern for marginalised people or species.

Hidden “spillover risks”. • Risks to the weak in society – Shifting resources to the economically competent? • Economic distortion – New property wealth and compensation – “Hidden” subsidies of market arrangements. – Secondary impacts on other resource uses • Intrinsic risks with monetisation – Partial pricing of total systems – “Crowding out” stewardship • Undermining policies and institutions. – Governance effects of ‘property-ising’ – Proliferating complexity and transaction costs

Concealed environmental spillover risks • Most (all? ) PES partially price ecological systems. – This does not equate to protection of all values. – “What gets rewarded is what gets done” or “What gets measured is what gets managed” reflect risks. • How much is a megalitre of water worth? – Costanza’s notional values -intrinsic problem of the absence of a true market. – Pricing based on a non-market administrative constraint. eg watershed services will not result in an “efficient equilibrium”.

e. g. biofuels governance market – focused innovation? • Transaction costs impediments, – particularly informational deficiencies – Supervisory costs and risks to the market • Path dependence – Institutional incapacity to implement innovations • Spillover – Emerging vs established industries • Public choice impediments.

Conclusions and possible directions

Natural Resource Governance • There are many, many positive developments and ‘experiments’ in sustainability. • But outcomes are highly variable, and lessons unexamined. Many policy failures can be identified. – Political – Instrumental – Implementation • Governance arrangements have not yet been able to reliably address fundamental challenges. – – A sufficient flow of resources to preserve and remediate. A sufficient shift in private behaviour to reduce harm-doing. Efficient, low transaction cost governance Fair sharing of costs and benefits.

Are we being misled by instruments? Instrument type Some legal aspects Behavioural mechanism? Who bears the cost? Markets Property rights Theft Trading rules Market entrepreneurship 1. arbitrage or 2. improve resource access or value. Consumer of resource bears the cost of consumption Avoidance of third party harm or ‘neighbourly’ negotiation of interests Offending user bears costs of avoidance of harm. Affected neighbour may bear costs. Both bear negotiated costs. Private Regulation Civil action Public Regulation Penalties Enforcement. Administration Compliance, focused on least cost to avoid the risk. Regulator bears the costs of enforcement. User bears the cost of compliance. Incentives Authority Contracting Public acountability Administrative entrepreneurship to - Win grants - Satisfy requirements The granting agency plus grant applicants. Education Authority. Constraints Civic responsibility Volunteers The Goal: to shift social systems, to sustain ecological systems Many Problems: failures, complexities, frustrations and cost. Causes: fragmented inefficient strategies. Effects: results can be insufficient, costly and unfair

What reforms are needed to regulatory design process? • Need to shift focus from individual instruments or policies towards the costs, impact and effectiveness of governance systems. • Instrumental risk identification/management needs to be institutionalised. • Regulatory impact assessment needs to be radically broadened in scope, and in content, to address the emerging risks.

Why should environmental law take this on challenge? Often lawyers, questioning the dominant paradigm, have asked whether the emperor’s new wardrobe is as glittering and complete as its’ tailors would have us believe. Lawyerly critical thinking applied to all forms of market instrument may be the essential impetus towards making them more reliable, more effective, and more equitable.